Stocks top savings accounts for income
February 08, 2012
With the average interest rate on savings accounts down to an average of 0.11 percent, people who need to earn income on their money are searching desperately for alternatives. Could stocks be the answer?
On the surface, that goes against what people have been taught traditionally: You turn to stocks for growth, but to bonds or savings accounts for income. However, with rates on savings accounts in unusually low territory, it may be time to consider an unusual strategy -- such as turning to stocks for income.
Income production: Stocks vs. savings accounts
As things stood at the end of 2011, stocks had a clear advantage over savings accounts when it came to income production. The S&P 500 stock index was yielding 2.10 percent, while savings accounts averaged 0.11 percent. That means that for every $100,000 invested in stocks, you could expect $2,100 a year in income via dividends. In contrast, savings accounts at 0.11 percent would produce just $110 in income.
Of course, deposit accounts are guaranteed, while stock prices fluctuate daily. More to the point for income-seekers, companies can cut their stock dividends in times of adversity. However, as bank customers have been reminded emphatically in recent years, banks can also cut the interest rates on deposit accounts -- and drastically. This raises a question: How does the stability of dividend production on stocks compare with the stability of interest rates on deposit accounts?
A good source of historical data on deposit accounts is the Federal Reserve's history of short-term CD yields. Looking at recent years, the history shows something you may already be painfully aware of: When the financial crisis and the Great Recession hit, CD rates dropped from 4.85 percent to 0.30 percent in just two years. On $100,000, this would have meant a reduction in annual income from $4,850 to $300, a cut of nearly 94 percent.
Stocks cut their dividends over the same period, but not nearly as drastically. Quarterly dividends per share on the S&P 500 dropped from $7.62 to $5.66 over that same period. An investor buying in with $100,000 at the end of 2007 would have seen annual income drop from $2,076 to $1,542 over the next two years, a decline of nearly 26 percent.
What to look for
Keep in mind that with stocks, both income and principal can fluctuate, so you should consider stocks for income production only if you have a long time horizon that won't require you to dip into principal in the foreseeable future. Also, you should make sure to choose a well-diversified group of stocks, since dividends on any individual stock can be cut drastically or eliminated altogether.
Finally, be aware that some types of stocks yield substantially more than others, with utilities and telecommunications stocks typically being good dividend earners, while technology and financial stocks offer much lower dividends on the whole.
